The significant increase in inequality in recent decades has sparked a wide debate on the possible implications for monetary policy. This paper uses a dynamic stochastic general equilibrium (DSGE) model with heterogeneous agents to evaluate the implications of consumption inequality for the conduct of monetary policy.
The optimal monetary policy that takes redistributive considerations into account reduces consumption inequality to a relatively small extent and at the cost of increased output gap volatility. Conversely, monetary policies that are based on the Taylor rule (which, by design, yields generally worse welfare outcomes) and incorporate an inequality reduction target in their formulation, may lead to a significant drop in inequality and a decrease in inflation and output gap volatilities.
